Oda Russian Commercial Law 2007-1

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A copy of the application is sent to the debtor (if the creditor or empowered body has made the application) and to the self-regulatory body of insolvency administrators for the preparation of the list of candidates as a provisional administrator. The application is accepted by a single judge, and within 15 days to 30 days of the decision of the judge con rming the acceptance of the application, the judge examines at the hearing whether or not the application is with grounds. Once the application for the recognition of the debtor as bankrupt is found to be with a ground, the judge introduces the observation procedure (Art.49, para.1). The hearing preceding the observation procedure is a novelty of the 2002 Law following a decision of the Constitutional Court which found the arrangement under the 1998 Law to be unconstitutional since it did not give an opportunity to the debtor to contest the decision of the court to proceed with the application.19

The creditor is entitled to apply for a security measure when applying for the recognition of the debtor as bankrupt and the commencement of the insolvency procedure. This application is considered by the judge within the next day without informing the debtor (Art.42, para.7).

2)Administrators

The Law set common rules for administrators appointed separately for observation, nancial restoration, external administration, and bankruptcy procedures. Under the 1998 Law, the creditor who les the application for the initiation of the procedure often exercised considerable in uence over the choice of the temporary administrator, and as a consequence, gains control over the entire procedure.20 In the light of such an experience the 2002 Law introduced a system aimed at improving the quality of administrators and ensuring their impartiality.

Administrators are required to:

i) Have higher education;

ii) Have an experience of an executive position of a juridical person for at least two years in total;

iii) Have passed a written examination for administrators;

19Decision of the Constitutional Court, March 12, 2001, Case No.4-P.

20A.S.Alexandrovich, “Bankruptcy Law, and Economic Medicine: How Russia’s New Bankruptcy Legislation Facilitated Recovery from the Nationwide Financial Crisis of August 17, 1998’, Cornell International Law Journal, vol.34, 2001, p.114.

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iv) Have worked as a trainee administrator for a minimum of six months;

v) To have no record of conviction for economic crimes, or for crimes of medium level seriousness or more;

vi) Be a member of one of the self-regulatory bodies. (Art.20, para.1)

The court may not appoint a person as an administrator, if this person is:

i) an interested party in relation to either a creditor or the debtor; ii) had an insolvency procedure initiated against himself;

iii) has not paid compensation for the loss caused to creditors, the debtor, or a third party while he served as an administrator;

iv) has been disquali ed or deprived of the right to hold an executive position etc.;

v) has not concluded an insurance contract for the potential loss resulting from the liability as an administrator.

(Art.20, para.6)

Creditors are entitled to require additional quali cations such as higher education in law, economics, or other relevant discipline, experience as an executive in a particular area of economy etc.

Self-regulatory organisations of administrators are set up throughout Russia. They are non-commercial organisations. Administrators must belong to a selfregulatory organisation.

One of the signi cant roles of the organisation is to prepare a list of candidates for the role of administrator in each case for the court. In the past, administrators were appointed by the court upon proposal of the creditors. This has led to the appointment of biased administrators. Therefore, under the 2002 Law, the procedure for appointing administrators went through a major change. The judge who conducts the initial procedure after receiving the application for the recognition of the debtor as bankrupt consults the self-regulatory organisation which prepares a list of three candidates. The debtor and the creditor who applied for bankruptcy are both entitled to strike offone candidate (Art.45, paras.1, 3 and 4). This procedure of selection of the administrator is applicable to provisional administrator who is in charge of the initial observation procedure as well as other administrators such as external and bankruptcy administrators.

Despite the tightening of control over administrators, corruption still takes place:

In the city court of Bashkirstan, an assistant to the administrator and the accounting of cer of the company who set aside assets of the company were convicted for abuse of of cial power. The external administrator who was approved by the commercial

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court lived in Moscow and had left the matter to an assistant. The assistant colluded with the accounting of cer and disposed of the factory and materials at a very low price. In the end, the company had to be liquidated.21

3)Observation (nabliudenie)

Observation is a procedure intended for the preservation of the debtor’s assets, analysis of the nancial state of the debtor, preparation of the list of creditors, and holding of the rst creditors’ meeting.

A provisional administrator is appointed at this stage. In the decision to commence the observation procedure, the judge con rms the provisional administrator selected via the procedure explained above in 2). The provisional administrator can be dismissed by the court upon the petition by a participant in the insolvency procedure for the non-performance or inadequate performance of duties which violates the rights or lawful interests of the petitioner, or would result in harming the debtor or a creditor (Art.65, para.3).

The commencement of the observation procedure has the following effects:

i) creditors may present their claims vis à vis the debtor only through the insolvency procedure;

ii) upon the petition by creditors, the court procedure vis à vis the debtor to collect the debt is suspended;

iii) enforcement procedure vis à vis the debtor is suspended;

iv) return of investment, buy-back of shares, payment of dividends, or payment of the value of shares is prohibited;

v) sett-off is prohibited, if it is against the priority of creditors set out by the Law.

(Art.63)

The incumbent management does not lose its power to manage the debtor-com- pany by the commencement of the observation procedure. However, their power is subject to restrictions. Transactions involving the acquisition, disposal of, or the possibility of disposing of the property of the debtor which is over 5% of the assets in the balance sheet (this used to be set at 10% in the 1998 Law), as well as receiving and extending loans, providing of guarantee, assignment of claims and assumption of debts requires the consent of the provisional administrator. It is prohibited to take a decision on:

21 Obzor deiatel’nosti arbitrazhnykh sudov v SMI, September 25, 2005, www.arbitr.ru.

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i) reorganisation (merger, split, conversion etc.);

ii) creation of a juridical person or participation in another juridical person; iii) creation of an af liate or a representative of ce;

iv) issuing of securities except for shares;

v) withdrawal of a member from the company or share buy-back; vi) participation in an association, a holding company group, etc.

(Art.64, paras.2 and 3).

It should be noted that increase of capital by issuing shares and allocating them to the founders (members) or a third party is allowed at this stage (Art.64, para.5).

The court, however, may remove the executives of the debtor company upon the request of the provisional administrator in cases of breach of law by the executives (Art.69, para.1).

Duties of the provisional administrator are:

i) adopt measures to ensure the preservation of the debtor’s assets; ii) analyse the nancial state of the debtor;

iii) identify the creditors of the debtor; iv) prepare a register of claims;

v) inform the creditors of the introduction of observation procedure; vi) convene and conduct the rst creditors’meeting.

(Art.67, para.1)

In order to take part in the rst creditors’ meeting, creditors are to present their claims to the debtor within 30 days of the notice of the court’s acceptance of the application for the recognition of the debtor as bankrupt. Claims should be forwarded to the court, the debtor and the provisional administrator together with the court judgment, contract, or other documents which certify the claim (Art.71, para.1). Objection to the claims can be made to court by the debtor, creditors, provisional administrator, and a representative of the founders (ibid., para.2). Claims found to be with grounds are entered into a register by the court.

This stage is crucial to creditors, since if their claim is not acknowledged, they will not be able to take part in the creditors’meeting and would fail to in u- ence the procedure. Under the 1998 Law, it was the provisional administrator, not the court who made the decision to register claims:

In a case involving Sidanco’s subsidiary, Kondpetroleum, the provisional administrator refused to acknowledge the existence of a claim by the parent company Sidanco, and the court upheld this decision. Sidanco argued that this was an abuse of power by the administrator who was close to Sidanco’s competitor, but the court rejected this argument.

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The provisional administrator convenes the rst creditors’ meeting. Known creditors as well as the representative of the employees are noti ed. The meeting takes place at least 10 days before the end of the observation procedure (Art.72, para.1).

At the rst creditors’ meeting, the executive of the debtor, representative of the founders (members) and employees take part without a vote.

The rst creditors’meeting may:

i) adopt a resolution and apply to the court for the introduction of nancial sanitisations;

ii) adopt a resolution and apply to the court for the introduction of external administration;

iii) apply to court for the recognition of the debtor as bankrupt and the commencement of the bankruptcy procedure;

iv) conclude an amicable settlement. (Arts.73, para.1, 74, para.4)

Creditors hold the number of votes proportional to the amount of their claim in relation to the total amount of the registered claim. The meeting stands if more than half the votes is represented (Art.12, paras.3 and 4). As a rule, decisions of the meeting are adopted by a majority of the votes represented at the meeting. However, decisions such as those listed above require a majority of total number of the votes of all creditors, regardless of their presence at the meeting (Art.15, paras.1 and 2).

Based upon the decision of the creditors’ meeting, the court renders a decision either to introduce nancial sanitisations or external administration, a decision to recognise the debtor as bankrupt and to commence the bankruptcy procedure, or con rms the amicable settlement and terminates the insolvency procedure (Art.75, para.1).

4)Financial Restoration ( nansovoe ozdrovlenie)

Financial restoration is a new procedure introduced by the 2002 Law. The term was known before, but at that time denoted measures taken by the founders, creditors or others before the application to the court for the recognition of the debtor as bankrupt. Now, it is an alternative procedure to external administration, bankruptcy, and amicable settlement. However, resorting to this procedure does not exclude the possibility of shifting to another procedure afterwards.

In the course of the nancial restoration procedure, the debtor repays the claims in accordance with the agreed schedule of repayment. During the observation procedure, the debtor, founders (members) of the debtor, or a third party

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may propose to the rst creditors’ meeting the introduction of a nancial restoration procedure. A copy of the proposal must be sent to the court as well as the provisional administrator (Art.76, para.1). Financial restoration is characterised as a procedure to provide guarantee for the repayment of debt.22 The debt can be repaid not only by the debtor, but also by those who guarantee its repayment. Founders (members) of the debtor company who agree to the nancial restoration are entitled to provide guarantee for the debtor’s repayment of the debt in accordance with the schedule of repayment (Art.77, para.3). A third party may, with the consent of the debtor, propose the introduction of nancial restoration. If the proposal comes from a third party, the intended guarantee by the third party(ies) needs to be indicated (Art.78, para.1). Guarantee may take the form of hypothec, bank guarantee, suretyship, or state or municipal guarantee (Art.79, para.1).

The plan for nancial restoration as well as the schedule of repayment prepared by the debtor must be attached to the proposal (Art.77, para.5). The plan for nancial restoration must contain the means by which the debtor is to receivenance for repayment of debts in accordance with the schedule such as borrowing or increase of capital.23

The court commences the nancial restoration procedure based upon the decision of the creditors’ meeting. In its decision to commence the procedure, the court con rms the administrator, endorses the repayment schedule and at the same time, determines the length of the procedure (Art.80, paras.2 and 3). The length of this procedure is maximum two years (Art.80, para.6). This is criticised as being too short for the implementation of large scale measures.24

The incumbent management is not deprived of its power by the commencement of nancial restoration procedure. However, upon the request of the creditors’ committee, the administrator, or the person who provided guarantee, the court may remove the executives of the debtor company in cases of inadequate implementation of the restoration plan or acts which infringe upon the rights and lawful interests of creditors and the provider of the guarantee (Art.82, paras.1 and 2). The debtor is not allowed to effect transactions involving the acquisition or disposal of the assets, extending loans and providing pledges etc. without the consent of the creditors’ meeting (ibid., para.3). Neither may the debtor effect transactions which increase the amount of debt by more than 5% or take out a loan without the consent of the administrator (ibid., para.4).

22V.V.Vitrianskii ed., Nauchno-prakticheskii kommentarii: Fderal’nyi zakon o nesostoiatel’nosti, Moscow 2004, p.323.

23Ibid., p.371.

24Karelina, supra, p.144.

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At least one month before the end of nancial restoration procedure, the debtor must submit a report on the result of nancial restoration. The administrator reviews the report and prepares an opinion which is sent to creditors and to the court. In cases where the claims of the creditors were not fully repaid, the court either adopts a decision to commence external administration or to recognise the debtor as bankrupt and commence the bankruptcy procedure. If the claims have been fully repaid, the procedure is terminated (Art.88).

In reality, nancial restoration procedure is not commonly utilised. In 2004, there were only 29 cases of nancial restoration, followed by 32 in 2005.

5)External Administration

External administration is a procedure for the restoration of the debtor’s solvency (Art.2). This is contrasted to the bankruptcy procedure (konkurs), which is aimed at liquidation and the subsequent distribution of proceeds from the sale of assets. The procedure is commenced by the court upon the decision of the creditors’meeting. The period of external administration is limited to 18 months, but can be extended for another 6 months (Art.93, para.2).

Unlike in the nancial restoration procedure, upon the introduction of external administration, the power of the executives of the debtor company is terminated by the commencement of this procedure. The external administrator takes over the power to manage the debtor company. The external administrator is empowered to dismiss the executives, or to transfer him to another position in accordance with Labour law. The power of the management bodies of the debtor company is also terminated and the management power is transferred to the external administrator, except for, inter alia, the following:

i) Amendments to the articles of incorporation for the increase of the capital; ii) Determination of the amounts and nominal value of declared shares; iii) Increase of capital by issuing supplementary ordinary shares;

iv) Submission of a proposal to the creditors’meeting to include in the agenda the possible supplementary issue of shares to the external administration plan;

v) Determination of the procedure of the general shareholders’meeting; vi) Submission of a proposal to dispose of an enterprise of the debtor;

vii) Substitution (zameshchenie) of the debtor’s assets by setting up one or several joint stock companies on the basis of the assets of the debtor;

viii) Appointment of the representative of the founders (members).

In contrast to the 1998 Law, it is now clear that the issuing of shares in order to restore solvency of the debtor is allowed only when the management body of the debtor company proposes it to the creditors’meeting and when it is included

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in the external administration plan.25 Another novelty is the right of the management body of the debtor company to make a decision on the disposal of its enterprise and to set the minimum price of sale (Art.94, para.2).

An important outcome of the decision of the court to commence external administration is the moratorium on the payment of the debt, including taxes and other mandatory payments (Art.94, para.1). The constitutionality of the moratorium in the 1998 Law was contested in the Constitutional Court. The court found this to be constitutional.26 There are exceptions to the moratorium such as current payments, arrears of wages, royalty for copyrights, compensation for the harm to life or health, and compensation of moral damages.

When commencing the external administration procedure, the court con-rms the external administrator. The procedure is set in the general part of the Law (Art.45).

The external administrator is selected from the list in accordance with the general rule. The administrator can be dismissed by the court:

i) On the basis of the decision of the creditors’ meeting in cases of non-perfor- mance or inappropriate performance of the duties by the administrator, or failure to implement the external administration plan;

ii) Upon petition by a participant in the procedure regarding the non-performance or inappropriate performance of the duties by the administrator which violates the rights and lawful interests of this party, or has brought, or is likely to result in harming the debtor or creditors;

iii) Cases where circumstances that prevent the person to be con rmed as an external administrator have emerged, or if after their con rmation, such circumstances were revealed.

(Art.98, para.1).

The external administrator has the power to:

i) dispose of the assets of the debtor in accordance with the external administration plan under the restrictions set out in the Law;

ii) conclude amicable settlement in the name of the debtor; iii) refuse the performance of contracts concluded by the debtor; iv) apply to court for invalidation of transactions and decisions.

The external administrator adopts the assets of the debtor for his management, prepares an inventory, and prepares the external administration plan to be submitted to the creditors’ meeting. He also express objection to the claims

25Vitrianskii, supra, p.416.

26Decision of the Constitutional Court, March 12, 2001, supra.

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presented by creditors if necessary and collects the debts owed. After the plan is approved by the creditors’ meeting, the administrator is responsible for its implementation (Art.99).

As compared to the 1998 Law, under which external administrators tend to abuse their power, the 2002 Law has signi cantly curtailed their power. “Practically, all powers of the external administrator for disposal of the assets of the debtor must not go beyond the external administration plan, and also is under the control of the creditors meeting”.27

Certain transactions effected by the debtor, including those effected before the commencement of external administration, can be invalidated by the court:

i) Transactions by the debtor with interested parties, the performance of which harmed or may harm the interests of creditors or the debtor, upon application of the external administrator;

ii) Transactions by the debtor with a speci c creditor or others concluded or performed after the application for the recognition of the debtor as bankrupt was accepted by court, or within six months before the application was led, provided that such transactions result in satisfaction of a claim of a creditor in preference to other creditors, upon the application of the external administrator or creditors;

iii) Transactions effected by the debtor within six months prior to the application for the recognition of the debtor as bankrupt was led involving pay-back of the contribution made by the founders (members) of a juridical person in relation to this person’s withdrawal from the organisation, if such a transaction violates the rights and lawful interests of creditors, upon application of the external administrator or creditors.

In addition, pay-back of contribution to the founders (members) of a juridical person in relation to this person’s withdrawal from the organisation after the application for the recognition of the debtor as bankrupt was accepted by court is null and void (Art.103, paras.1-5).

The external administrator prepares a plan of external administration within one month of his con rmation by the court and submits it to the creditors’meeting for approval. This plan must contain a proposed measure for the restoration of the solvency of the debtor, the terms and procedure for realising it, and the costs (Art.106, para.1). Measures for the restoration of solvency include (Art.109):

27 Vitrianskii, supra, pp.435-436.

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i) changing the pro le of production; ii) closing of loss-making production; iii) collection of debts;

iv) sale of part of the debtor-organisation; v) assignment of claims of the debtor; vi) performance of the debt by a third party;

vii) increase of capital by contribution from the members or a third party; viii) issuing of supplementary common shares;

ix) substitution of the assets of the debtor; x) sale of enterprise(s) of the debtor.

It should be noted that the sale of enterprises of the debtor was often abused under the 1998 Law. The 2002 Law introduced major changes to the system. First of all, the sale of enterprises can only be included in the plan on the basis of the proposal of the management body of the debtor. Second, a public auction is mandatory, and the minimum price is set by the debtor.28

Substitution of the assets of the debtor was introduced in Russia after thenancial crisis under the procedure led by ARKO. On the basis of the assets of the debtor, an open joint stock company is founded. The debtor is the 100% owner of this company. Other than the shares of this company, there are no assets left with the debtor. In due course, the shares of the company will be sold and the debts will be repaid from the proceeds.29

The creditors’meeting is convened by the external administrator within two months of his con rmation by the court. The creditors’meeting may:

i) endorse the external administration plan;

ii) reject the plan and apply to court for the recognition of the debtor as bankrupt and the commencement of the bankruptcy procedure;

iii) reject the plan of the external administrator and have another meeting convened in order to examine another plan;

iv) reject the plan and remove the external administrator.

(Art.107, para.3)

The court is empowered to recognise the plan as invalid as a whole or in part upon the request of a person whose rights or lawful interests were infringed.

Once the plan is adopted by the creditors’meeting and approved by the court, the external administrator is responsible for the realisation of the plan under the

28Ibid., p.482.

29V.F.Popondopulo, Kommentarii k federal’nomu zakonu “o nesostoiatel’nosti”, Moscow 2003, pp.248-250.